China’s AIIB Recasts Development Finance — and U.S. Influence

China’s success in securing 57 founding members for its new regional lending institution, the Asian Infrastructure Investment Bank (AIIB), signals the real limits of U.S. influence in the region in the post-Cold War era. As of the March 31 deadline for initial applications to join the AIIB, among major industrial powers only U.S. ally Japan, so far, has spurned Beijing’s plan.

Britain, Germany, France, Italy, Australia and South Korea are among the dozens of countries that have signaled their intention to be founding members of the new bank. China’s coup in economic diplomacy comes as negotiations for the U.S.-backed Trans-Pacific Partnership, or TPP, once again appear stalled, with little prospect for a consensus in coming months.

China’s plans call for setting the AIIB’s initial authorized capital at $100 billion, with China providing up to 50% of that amount. Subscribed capital is set at $50 billion. It is still too early to say if China’s new lending institution might supplant the International Monetary Fund (IMF) and World Bank as a major source of financing for infrastructure projects, analysts say. The outcome will depend partly on the ground rules, or “articles of association,” for the AIIB Charter.

What is certain is that the AIIB as envisaged so far dovetails with China’s own geopolitical and commercial interests in expanding its economic reach and trade networks in Southeast Asia, South Asia and Central Asia.

Japan Holds Out

Japan has so far hedged its bets, refraining from joining, but saying it is awaiting a reply from China to questions it has raised over how the AIIB will be run. A decision to not join in the long run could put a dent in Prime Minister Shinzo Abe’s effort to boost exports of major Japanese infrastructure services, products and technology. Japanese media have cited officials saying that Tokyo is still considering whether to sign on. But Japan lacks the ability to defy the U.S. in setting its own policy on such issues, says Kazuo Yukawa, an expert on contemporary China and professor at Asia University in Tokyo.

The AIIB is part of a grand scheme rolled out by President Xi Jinping beginning in 2014 for developing a modern “Silk Road Economic Belt” and 21st century Maritime Silk Road to finance construction of a network of highways, railways and other infrastructure linking China to Central and South Asia, the Middle East and Europe. At the annual APEC (Asia-Pacific Economic Cooperation free trade association) summit in Beijing in November, Chinese President Xi announced that China would contribute the entire $40 billion in its new Silk Road Fund to improve trade and transport links in Asia.

“The AIIB is motivated by multiple factors, one is geopolitical and one is purely economic Twitter, because once this bank exists, combined with the Silk Road Fund, it will begin to finance a lot of infrastructure, particularly railway infrastructure, in Central Asia, Western Asia and South Asia and even in the Middle East,” says Pieter P. Bottelier, a former senior World Bank official. “If that works, it will enable the Chinese to export excess capacity of large industry, such as the state-owned railway manufacturing industry.”

While it is clearly in Beijing’s commercial interest, the plan also is presented as a way to bridge shortages of infrastructure financing across the region, ideally, enabling countries that lag behind to close their development gap. Given that strong selling point, experts say U.S. objections to the plan rang hollow and reinforced Chinese convictions that Washington is seeking to “contain” China.

“The probable explanation would be that U.S. did not want China to have such a very powerful instrument for foreign policy such as AIIB. Staying out and recommending allies to stay out — Japan, South Korea, Australia and European countries — in China’s eyes, that confirmed that [the U.S.] wants to limit the rise of China,” says Bottelier, who is now a senior professor of China studies at the School of Advanced International Studies at Johns Hopkins University in Baltimore.

Failed U.S. Strategy

The consensus in the field of international finance and Asian diplomacy is that the U.S. strategy toward AIIB so far has failed. “I think China has played this quite ably and the U.S. played it about as badly as it possibly could,” says one former senior official of a multinational development bank, who declined to be named. Franklin Allen, a Wharton professor of finance agrees. “America just looks so silly because the U.S. asked other countries not to go in, but now all those countries except Japan are going in. It has been a very successful Chinese move,” Allen says. Allen is also a professor at Imperial College in London and head of its Brevan Howard Centre.

“America just looks so silly because the U.S. asked other countries not to go in but now all those countries except Japan are going in.”–Franklin Allen

China has been seeking for years to gain a bigger role in existing institutions such as the International Monetary Fund, the World Bank and the Asian Development Bank (ADB). China has only a 4.2% stake in the World Bank while the U.S. has a 15.8% stake and Japan has a 6.8% stake. The U.S. and Japan have 15.6% and 15.7% stakes, respectively, in the ADB, while China’s is just 6.5%.

Customarily, a Japanese official chairs the ADB — Japan’s central bank governor, Haruhiko Kuroda, was president of the ADB before returning to Tokyo, when he was succeeded by a finance ministry official, Takehiko Nakao. “It is kind of strange that China is so underrepresented at the IMF and World Bank,” Allen says. “It is not surprising that China is doing this.”

Knowledge@Wharton High School

Since the U.S. has so far failed to win approval by Congress for IMF reforms, it was in no position to oppose the AIIB, says the former senior official of a multinational development bank. “U.S. government officials could have just asked the question, ‘What is China’s vision for the new bank and how would it be different from the ADB and World Bank?’ and then sat back and seen how things developed. But they attacked it instead, lobbied others not to join and, having failed to stop the Brits from joining, committed the original sin of whining to the world about their failure. It’s embarrassing.”

“This is a huge mistake that the U.S. made and it cannot be corrected,” adds Bottelier. “Even if the U.S. applies for membership now, I think the damage has already been done. I do not understand it at all. Whoever recommended that President Obama do what he did should be fired. I think it was one of biggest foreign policy blunders that U.S. has made in years.”

In opting to back the AIIB, Britain and other major Western nations were not joining a “gold rush” but were acting on the premise that the American approach was mistaken, Bottelier adds. “Europeans want to do more business with China and they do not have security concerns about China,” says Allen. “I think that they realized that China is not a threat to them at all, so they are better off to join. In fact, they would like to balance the Russians with the Chinese, so they are quite willing to do this.”

Another of Xi’s aims is to undermine President Barack Obama’s “pivot to Asia” and the push for the dozen-nation TPP, an Asia-Pacific rim trade zone that so far excludes China. Awkwardly for the U.S., almost all of the countries participating in the TPP talks plan to join the AIIB, which is lacking the “high hurdles” laid out by the U.S. as a condition for joining the pan-Pacific trade bloc.

Apart from pushing ahead with its own trade pact, the Free Trade Area of the Asia Pacific, Beijing is tapping its $3.89 trillion in foreign exchange reserves to set up multinational bodies like the AIIB, the BRICS Bank and a bank for the Central Asian-oriented Shanghai Cooperation Organization Bank, while still seeking to increase its influence at the ADB and the World Bank. In July, the BRICS group, which also includes Brazil, Russia, India and South Africa, agreed to set up a bank to be based in Shanghai by 2016.

Questioning the need for yet another multilateral lender, Japan and the U.S. have raised concerns over whether the AIIB would have a transparent governance structure and adequate standards for project selection, preparations, procurement, and environmental impact and resettlement. After years of working to reform and improve standards at the World Bank and other lenders, the worry is that AIIB might undercut them for the sake of commercial or political expedience.

“This is a huge mistake that the U.S. made and it cannot be corrected.”–Pieter P. Bottelier

China Forgoes Veto Power

To assuage such concerns, China offered to forego veto power at the AIIB, in a move that helped win over major European countries, according to a March 23 report by The Asian Wall Street Journal. That would be a change from IMF practice, where the U.S. holds the right to nix big decisions despite holding less than 20% of voting shares, a structure that has long raised complaints.

“My understanding is that the Chinese have agreed that they will not have similar clauses in the charter of the AIIB, which is being drawn up,” Bottelier says. “By giving up veto power, China is teaching the U.S. a lesson on multilateralism.”

The AIIB is bound to give strong voting rights to Asia, says Rajiv Biswas, Singapore-based chief Asia Pacific economist at IHS Economics. “China will have a big role as they are putting up half of the money and they are going to need reasonable voting rights. They will not want a situation where the U.S. and Europe will hold most of votes. But we do not know. A lot of discussion has to take place about how to distribute the voting rights. So far, it is not clear what the rules of governance will be.”

One reason many European countries joined the AIIB from the outset is to have a say in how it is structured and governed. “If they wait until later on, it may be too late to change the structure. Now is the time to join, before it is established, if you want to have influence,” Biswas says.

A team in Beijing, led by AIIB Secretary General Jin Liqun, a veteran of the Chinese central bank, China’s sovereign investment fund, the China Investment Corp., the World Bank and ADB, with help from several Chinese and American retired World Bank staffers, is drafting Articles of Association that will have to be approved by the AIIB’s founding members before the Bank can formally open for business, says Bottelier. “All these concerns are expressed without any knowledge of what the final charter of this bank will look like,” he says. “So the criticism is premature. Once we know the charter, it will be time to express our opinions.

“I don’t think we know yet on what terms the newly established Silk Road Fund will make available funds for infrastructure financing outside China. It could be tied loans; it could also be untied loans and/or grants,” Bottelier adds. “The AIIB has not yet been formally established.”

Politics and governance aside, the need for infrastructure investment and financing is massive not only in Asia, but also other parts of the developing world. The Asian Development Bank estimated its region alone faces an annual financing shortfall of $800 billion. McKinsey & Co. estimates the global infrastructure investment requirement through 2030 at $57 trillion to $67 trillion. “The reality is Asia needs a lot of money for infrastructure development and the ADB does not have enough money to provide that kind of funding,” Biswas says. “Asia needs trillions of dollars over the next 10 years. The AIIB is only $100 billion, but it helps.”

The ADB has adopted a neutral attitude toward the AIIB plan. ADB President Takehiko Nakao said in a statement after a March 24 meeting with Chinese Premier Li Keqiang, “When the Asian Infrastructure Investment Bank (AIIB) is formally established, adhering to international best practices in procurement and environmental and social safeguard standards on its projects and programs, ADB will be happy to consider appropriate ways of cooperation.”

On March 24, Obama’s administration, seeing that all America’s allies except Japan are applying to be founding members of the AIIB, proposed that the AIIB work in partnership with the World Bank and ADB. “The U.S. would welcome a new multilateral institution that strengthens the international financial architecture,” said Nathan Sheets, the U.S. Treasury’s undersecretary of international affairs. “Co-financing projects with existing institutions like the World Bank or the Asian Development Bank will help ensure that high quality, time-tested standards are maintained.”

Said the former senior official of a multinational development bank: “I had also heard that the U.S. was encouraging the ADB and AIIB to co-finance projects in the near term until AIIB has some staff and experience. That’s a great idea and I hope it happens. I do not know how Japan’s [Ministry of Finance] feels about it, but I would guess Nakao is open to it.”

Environmental and governance issues actually are hindering financing for infrastructure development in developing countries, “so to a certain degree what China is saying is true, that there is a big need to provide infrastructure investment in the developing countries,” the official notes.

“The reality is Asia needs a lot of money for infrastructure development and the ADB does not have enough money to provide that kind of funding.”–Rajiv Biswas

Environmental Work-around?

But U.S. officials worry that China may provide money to some countries with dictatorships or may ignore environmental issues and lend the money, said a China expert who declined to be named. “Initially, there was concern because people thought it will be mainly an organization controlled by China, with many developing countries as members.”

Now, however, it looks like a lot of European countries will be members as well. So the standards will be set according to the agreement of all these countries, says Biswas. “The chances are high that the standards will be set high.” Much will become clear in the next several months as the organization negotiates over voting rights, governance and lending standards.

Toshiya Tsugami, a China expert and managing director of Tsugami Workshop Co., a consulting company, says that if China tries to use AIIB in tandem with the Silk Road Fund to pursue Beijing’s “One Belt and One Road” investment strategy, it could lead to conflicts of interest.

China has been clear about its other motives: opening up new markets for domestic industries troubled by excessive production capacity; growing the outbound investment of its state enterprises, and diversifying the use of huge foreign currency reserves.

China has serious excess capacity problems in heavy equipment manufacturing (including train and locomotive manufacturing) and in construction, Bottelier points out, so the motivation for setting up the AIIB may well be partly related to that. “Wouldn’t you try to do something like that if you had China’s excess capacity problem and nearly $4 trillion in forex reserves that earn almost nothing?” he asks.

But he expects that despite the obvious self-interest, contracts for AIIB loans will likely be based on international competitive bidding, as is the case for the ADB and the World Bank. “Otherwise, the 57 other founding shareholder countries would not agree to its articles,” Bottelier says.

Still, China is maneuvering from a position of strength, having already set up the $40 billion Silk Road Fund, which is financed and completely controlled by Beijing.

“China is a big player in providing development finance for other Asian countries and that may mean that those countries are using the money to buy Chinese railways, or using Chinese engineering companies to build the railways,” Biswas says. “China wants to play a greater leadership role in the Asia Pacific region and in emerging markets around the world. In Asia, China is a big lender and that will increase its influence in the region.”

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8 Comments So Far

DavidEH Smith

Global Treaties Not about How Much Trade, but, How & Who to Trade with and ‘Undermine’ AIIB. How Sure are You that their are NO ‘Future Considerations’ Paid out by TPP, et al, ‘Foreign’ & Domestic Lobbyists?

The limited number of direct beneficiaries of the TPP (China -Canada Investment Treaty)& the other global treaties (ie. the global corporate leaders & their ‘preferred’ shareholders), are most desperate to keep from the prying, due diligence eyes of the of the potential global un-preferred shareholders’ & the harmless NON shareholders.

The fact of the matter is, the flurry of global treaties have very little to do with trade. The treaties are about ‘preferred’ trading partners who are successfully attempting to legitimize for the signatories of the treaty/’Arrangements’, settlements of the TPP’s ‘contrived’ disputes, et al, by enabling the parties to alleged ‘disputes’ to use non adversarial settlements whereby,
the corporations & preferred shareholders ‘merely’ shift all of their costs from themselves to the harmless NON shareholder & the un-preferred shareholders, ie. the general public/individual taxpayers.

These costs include the costs of determining:
1) which harmless non shareholders will have to pay corporations & some SHAREHOLDERS (‘preferred’ SHAREHOLDERS) for the corporations’ ‘mistakes’, contrivances, unrealistic, &/or, any expectations, etc.,
2) how high (win-fall) the punitive penalties, awards, damages, etc. will be
without the harmless NON shareholder being represented throughout the determination
of, not, if the NON shareholders are guilty, but, ‘merely’ how ‘guilty’ the harmless NON shareholders are with no means/opportunity to appeal the decisions by way of the Treaties’ (‘Death-Star-Chamber’) new superseding, cyber jurisdiction Tribunals,
&
3) et al.
For Further Information, see,
‘TPP & Global Treaties & Anti AIIB’ below.
Also see;
‘The Submission’ to The SUPREME COURT of CANADA:
“The SHAREHOLDERS & Corporations of AMERICA, Australia, Canada, the EU, et al
v
the harmless Canadian NON shareholders, both; Native & non Native, et al”
including
‘The MERKEL (Chancellor of Germany) Letter; To Sue, or, Be Sued?’
(see; davidehsmith.wordpress.com)
***
TPP & GLOBAL TREATIES;
IS HOLLYWOOD PART of the (TPP Global Treaty & Anti AIIB) PROCESS, or, OUT-of-the LOOP, too?
– L.A. Times, Apr. 7, 2015, blog

It may regrettable that the simplest & most basic information & questions that can lead to a much more secure & profitable relationship between the potential signatories of the TPP & China, et al, has not been shared with Defense Secretary Carter for his humble consideration. Perhaps, he may consider answering some of the enclosed questions in order for us to get a better idea of what his understanding is of how the TPP & other Global Treaties can be vastly improved inclusively & thereby, minimize, &/or, eliminate the dangerous problems below that have led some to understand that

‘What the TREATY of VERSAILLES was to the 20th century (ie. provided the basis for World War II) PALES in COMPARISON to the TPP, CETA, C-CIT, NAFTA, et al, in the 21st’.

Unless, of course, the long term economic destabilization and subsequent (secret) military weapons development & appropriations are the intent of DefSec Carter, et al, in the secret (Death-Star-Chamber) ‘arrangements’ of the TPP & the Global Corporate Treaties/Agreements.
***
But, how many ‘savvy’ Americans & their global corporate associates are ‘poised’ to make windfall profits from their international cross investments, ‘nest-feathered’ lawsuits & preplanned treaty ‘arrangements’ at the direct expense of the harmless non shareholders, ie. 95% – 99% of America , et al?
***
While the good sales folks of Wall St. may prefer to tell their ‘Enron-able’ customers who were also the victims of ‘The Preliminary Foray of The Wall St. Meltdown’, et al, that it’s just some Unions that are fighting back, how much of the Fighting Back of Unions against the Secret, Unethical & Anti-Democratic Arrangements of The Global Treaties’ ‘Death-Star-Chamber’ Tribunals, can be understood in the context of the harmless NON Shareholders, including Union members, fighting to Survive (not ‘thrive’) Against the Uncaring, ‘Profits at Any (body else’s) Costs’, SHAREHOLDERS & their Colluding, Global Corporate Leaders?
– Washington Post, blog, Mar. 25, 2015

But, If Not PUTIN; ‘The WHITE KNIGHT’, then Who Do YOU Want to Bankroll the Saving of the harmless NON shareholders of the World from Fast Tracking TPP’s, CETA’s (TTIP) Secret ‘Death-Star-Chamber’ Tribunal Penalties?
Will China, Iran, the Muslim World, et al, Support Putin in Suits?
How about Warren Buffett, &/or, the ‘coveted’ Hong Kong investor, et al?
***
FULL Article, see; davidehsmith.wordpress.com
***
Please consider sharing the enclosed information & questions with 10 friends who will share it with 10 others…

Bajie Zhu

China’s goal is set far higher than just getting better returns on the foreign currency reserves.

To continue doing well in a clearly competitive world, a nation, any nation, must pick one or more areas of expertise, so that the comparative advantage would sustain continued growth.

China picked infrastructure building as one such major area.

The AIIB and other myriad newfangled institutions (BRICS Bank, Silk Road Fund, etc.) are not about dominating the economies in question. They are a humongous jobs program. China over the past 40 years has garnered a very big competitive advantage in infrastructure engineering and building. It has the only viable expertise in 24 hours a day (3 shifts) 7 days a week engineering. This is further backed by a very large group of export ready suppliers of construction machinery, construction materials (steel, cement, etc., all No. 1 in the world in terms of size); and now of course the milieu includes the availability of CAPITAL. Already Chinese engineering companies can bid 30% less than their Western counterparts and still make money. By helping and enabling the poorer nations in the world to build infrastructure, China fully expects (and very likely will) create profitable, sustainable jobs for its export of infrastructure related goods and services.

It is absolutely true that the AIIB would not be enough to meet the Infrastructure needs of Asia, let alone the world. But that is missing the point.

The AIIB is just a catalyst. Infrastructure needs for Asia alone is US$8 Trillion for the next 10 years. China is willing to lend (bilateral diplomacy here) OUTSIDE of these multilateral institutions, and Chinese engineering companies can have most of that business which also benefits the infrastructure related industrial exporters – steel, cement, construction machinery, construction materials, etc. In one or two years there will be major projects (hundreds of billions of dollars) funded by the AIIB; in 5-10 years there will be 10 times as much infrastructure building funded by China (in bilateral arrangements). The goal is IMMEDIATE PROFITABLE JOBS CREATION.

Bajie Zhu

None of that would probably happen if America acts less thuggish and more accommodating. The world benefits from a G2 of equals.

Yet the hubris continues. The first thing that the American Treasury Secretary did after returning to the U.S. from his Beijing a couple of weeks ago, was to forceful propound (during an Asia Society speech) that the RMB is unfit to join the IMF’s SDR (basket of reserve currencies). It appears that Jack Lew got diddly squat in Beijing this week. The SDR tizzy fit is to firmly demonstrate who is boss, after seriously losing face in the AIIB debacle – America is telling the Chinese that “you still can’t play unless I let you.” Along the same vein, America excludes China from the TPP negotiations.

But China has alternatives. Just as America continues to block IMF reforms (passed since 2010), China puts into action the BRICS bank, the various Silk Road funds, and now the AIIB. Despite the irrational ill-wishing from the hegemon, the world NEEDS and WELCOMES the alternatives.

The reason for China to seek including the RMB in the SDR is to increase circulation of the RMB outside China. In context, there are $32 Trillion American dollar denominated debts outside America. China could render the SDR rather irrelevant in one stroke. China can extend up to 100 Trillion RMB (US$16 Trillion) in low interest RMB loans to central banks around the world, suitable for buying Made in China products and services (but not for cross border investments into China). Not to mention also the possibility of denominating oil payments in RMB. Such a “nuclear option” would leave capital controls intact, giant shot in the arm for exports, instant circulation outside the border.

Impossible? implausible? Just this week it was announced that China is signing up for US$42 billion in projects in Pakistan. Multiple that by 100 countries, that is already US$4 trillion right off the bat.

Bajie Zhu

The AIIB debacle also foreshadows the phase out of SWIFT as the predominant (and U.S. controlled) payment platform. China’s CIPS is currently being tested by 20 Chinese banks and 13 foreign banks. Formal launch is expected in Sept. or Oct. of 2015.

Given America’s gross abuse of its power in operating and controlling SWIFT: French bank PARIBAS was fined US$8.9 billion for aiding Cuba and Iran in trade, even though that is legal under French law. More fines were levied against the biggest of big banks of American allies – Commerzbank of Germany, Charter Bank and HSBC of the UK, UBS and hundreds of Swiss banks. Everyone had to pay up (asked how high when America said jump), since the “alternative” would be the equivalent of the death penalty – the financial house being excluded from SWIFT.

They paid, but it does not mean that they do not mind the humiliation at the hands of the hegemon. Given a chance, they all will seek alternatives. The adoption of CIPS could very well be explosive.

Mike Mattes

Washington is seeking to “contain” China. Why would there be a reason to do so? Ask the neighbors surrounding China why they think the Chinese hegemon should be contained or restrained? Military build-up. Aggressive behavior in the South China Sea. Transgressions against the national sovereignty of many smaller countries in Asia.
Given China’s past behavior in theft of intellectual property and aggressive espionage, there is also good reason to restrain such behavior.
What alternatives will the world “need” and “welcome” when it’s marching to the beat of a Chinese drum???

Mike Mattes

Mr. Zhu, I would like to know what the Chinese word for “thuggish” is because it most certainly pertains to them!

Mike Mattes

“Europeans want to do more business with China and they do not have security concerns about China,” The Europeans would be singing a quite different tune if they were sitting in the same position as Japan, the Phillippines, Vietnam or Taiwan. Just to name a few.

Z Song

Mike

All the countries you mentioned except Japan has joined AIIB. Taiwan applied for the founding member but was rejected, they will apply for the ordinary member in the future.